Registered Retirement Savings Plan (RRSP)

A Registered Retirement Savings Plan (RRSP) is a type of Canadian account for holding savings and investment assets. An RRSP is a plan that you establish and register with Canada Revenue Agency (CRA), and to which you or your spouse or common-law partner contribute. Deductible RRSP contributions can be used to reduce your tax. Any income you earn in the RRSP is usually exempt from tax as long as the funds remain in the plan; you generally have to pay tax when you receive payments from the plan.

Introduced in 1957, the RRSP’s purpose is to promote savings for retirement by employees. It must comply with a variety of restrictions stipulated in the Canadian Income Tax Act. Rules determine the maximum contributions, the timing of contributions, the claiming of the contribution tax credit, the assets allowed, and the eventual conversion to an RRIF (Registered Retirement Income Fund) in retirement. Approved assets include savings accounts, guaranteed investment certificates (GICs), bonds, mortgage loans, mutual funds, income trusts, corporate shares (stocks), foreign currency and labour-sponsored funds.

RRSP Has Five Effects

Taxes on earned (employment) income (to the extent contributed to the plan) are deferred until the eventual withdrawals from the plan. There is no benefit from the deferral because it is an accrued liability that grows at the same rate as the investments themselves. The tax deferred is commonly called the contribution tax credit.

Income earned inside the plan on the after-tax savings (excluding the contribution tax credit) is not taxed either while within the plan or on withdrawal. Asset classes that attract the highest taxes (%income x %tax rate) are best kept within the plan to maximize the deferral benefit.

One’s marginal tax rate when withdrawing cash may be higher (or lower) than the rate at which one claimed the original contribution credit. This creates a penalty (or benefit) equal to (change in tax rate %) divided by (1 minus tax rate on contribution).

Canada has a variety of programs available to retired people whose benefits decrease as one’s income increases. By deferring the income until retirement, the additional income created at that time may reduce those benefits.

Claiming the contribution tax credit may be deferred until a later year (when the expected marginal tax rate is higher), but there is an opportunity cost penalty for the delay; the potential income the tax credit could have earned during the delay.

Types of RRSPs

RRSP accounts can be set up with either one or two associated individuals:

Individual RRSP: An Individual RRSP is associated with only a single individual, termed an account holder. With Individual RRSPs, the account holder is also called a contributor, as only they contribute money to their RRSP.

Spousal RRSP: A Spousal RRSP allows a higher earner, termed a spousal contributor, to contribute to an RRSP in the spouse’s name. In this case, it is the spouse who is the account holder. The spouse can withdraw the funds, subject to tax, after a holding period. A spousal RRSP is a means of splitting income in retirement: By dividing investment properties between both spouses each spouse will receive half the income, and thus the marginal tax rate will be lower than if one spouse earned all of the income.

Group RRSP: In a group RRSP, an employer arranges for employees to make contributions, as they wish, through a schedule of regular payroll deductions. The employee can decide the size of contribution per year and the employer will deduct an amount accordingly and submit it to the investment manager selected to administer the group account. The contribution is then deposited into the employee’s individual account and invested as specified. The primary difference with a group plan is that the contributor realizes the tax savings immediately, instead of having to wait until the end of the tax year.

Pooled RRSP: Legislation was introduced during the 41st Canadian Parliament to create Pooled Retirement Pension Plans (PRPP). PRPPs would be aimed at employees and employers in small businesses, and at self-employed people.

CONTRIBUTING to RRSP

A RRSP deduction limit is the maximum amount of RRSP contributions that can be claimed on a tax return for a given tax year. A deduction limit is calculated as the unused deduction limit from the prior year (which includes all unused deductions going back 10 years), plus 18% of a person’s earned income from the previous calendar year up to a specified maximum, minus any pension adjustment (PA) and past service pension adjustment (PSPA), plus pension adjustment reversals (PAR). The CRA calculates the RRSP deduction limit for the next year and prints it on every Notice of Assessment or Reassessment, provided the taxpayer is aged 71 years or younger. It is also recalculated and a copy mailed in certain cases such as when a PSPA or PAR is issued.

Age limit for contributing to an RRSP

The year you turn 71 is the last year in which you can make a contribution to your RRSP. If you cannot contribute to your RRSP because of your age, you can still contribute to your spouse’s RRSP or common-law partner’s RRSP until the end of the year he or she turns 71.

Contribution Limit

The specified maximum has been rising: in 2002 the contribution limit was $13,500 and in 2013 is $23,820. After 2010 the RRSP contribution limit is indexed to the annual increase in the average wage. After filing a tax return (or any adjustments to the tax return), each taxpayer receives a Notice of (Re)Assessment from the Canada Revenue Agency, indicating their new RRSP deduction limit. While it is possible to contribute more than the contributor’s deduction limit, it is generally not advised as the excess amount ($2,000 over the deduction limit) is subject to a significant penalty tax removing all benefits (1% per month on the overage amount). RRSP contributions within the first 60 days of the tax year (which may or may not be the calendar year) must be reported on the previous year’s return, according to the Income Tax Act. Such contributions may also be used as deduction for the previous tax year. Note that reporting and using are two different things. All other contributions may be used in the same tax year or held for future use.

Example 1

Tom’s 2011 RRSP deduction limit is $9,500. Tom contributes $4,000 to his RRSP in 2011, and $6,000 to his common-law partner Anna’s RRSP in 2011. Tom deducts the $4,000 he contributed to his RRSP on line 208 of his 2011income tax return. Although Tom contributed $6,000 to his common-law partner’s RRSP in 2011, he can only deduct $5,500 of this contribution on his 2011 return ($9,500 – $4,000). He may be able to deduct the remaining $500 on a future year’s tax return.

Contributions Made After Death

No contributions can be made to a deceased individual’s RRSP after the date of death. However, the deceased individual’s legal representative can make contributions to the surviving spouse’s RRSP or common-law partner’s RRSP in the year of death or during the first 60 days after the end of that year. Contributions made to a spouse’s RRSP or common-law partner’s RRSP can be claimed on the deceased individual’s return, up to that individual’s RRSP deduction limit for the year of death.

Example 2

Dave died in August 2011. His 2011 RRSP deduction limit is $7,000. Before he died, Dave did not contribute to either his RRSP or his wife’s RRSP for 2011. His wife Paula is 66 years old in 2011. On Dave’s behalf, his legal representative can contribute up to $7,000 to Paula’s RRSP for 2011. The legal representative can then claim an RRSP deduction of up to $7,000 on line 208 of Dave’s 2011 final return.

RRSP Taxation

For the most part, contributions to RRSPs are deductible from taxable income, reducing income tax payable. Since Canada has a progressive tax system, taxes are reduced at the highest marginal rate. Increases in the value of the plan assets (whether capital gains, interest income or other) are not subject to income or other taxes in Canada until funds are removed from the RRSP. Disbursements from an RRSP are taxable as income at the time of withdrawal regardless of the type of profit earned while inside the RRSPs.

Withdrawals from RRSP

An account holder is able to cash out an amount from an RRSP at any age. However, any amount withdrawn qualifies as taxable income and is therefore subject to withholding tax. Before the end of the year the account holder turns 71, the RRSP must either be cashed out or transferred to a Registered Retirement Income Fund (RRIF) or an annuity. Until 2007, account holders were required to make this decision at age 69 rather than 71. Investments held in an RRIF can continue to grow tax-free indefinitely, though an obligatory minimum RRIF withdrawal amount is cashed out and sent to the account holder each year. At that time, an individual’s income is expected to be lower and therefore subjected to less tax.

Special Withdrawal Programs

Home Buyer’s Plan (HBP): While the original purpose of RRSPs was to help Canadians save for retirement, it is possible to use RRSP funds to help purchase one’s first home under what is known as the Home Buyer’s Plan. Canadians can borrow, tax-free, up to $25,000 from their RRSP (and another $25,000 from a spousal RRSP) towards buying their residence. This loan has to be repaid within 15 years after two years of grace. Contrary to popular belief, this plan can be used more than once per lifetime, as long as the borrower did not own a residence in the previous five years, and has fully repaid any previous loans under this plan.

Lifelong Learning Plan (LLP): Similarly to the Home Buyer’s Plan, the Life-Long Learning Plan allows for temporary diversions of tax-free funds from an RRSP. This program allows individuals to borrow from an RRSP to go or return to post-secondary school. The user may withdraw up to $10,000 per year to a maximum of $20,000. The first repayment under the LLP will be due at the earliest of the following two dates: 1) 60 days after the fifth year following the first withdrawal, and 2) the second year after the last year the student was enrolled in full-time studies.

RRSP Account Structure

Both Individual and Spousal RRSPs can be held in one of three account structures. It should be noted that one or more of the account types below may not be an option depending on what type of investment instrument (example stocks, mutual funds, bonds) is being held inside the RRSP.

Client-held accounts: Client-held, or client-name accounts, exist when an account holder uses their RRSP contributions to purchase an investment with a particular investment company. Each time that an individual uses RRSP contribution money to purchase an investment at a different fund company, it results in a separate client-held account being opened. For example, if an individual buys investment # 1 with one company and investment # 2 with another, this would result in the individual having two separate RRSP accounts held with two different companies. The main benefit of client-held accounts is that they do not generally incur annual fees. The main detriment is that investors must keep track of each RRSP investment made with each separate company.

Nominee accounts: Nominee accounts are so named because individuals with this type of account nominate a nominee, usually one of Canada’s five major banks or a major investment dealer, to hold a number of different investments in a single account. For example, if an individual buys investment # 1 with one company and investment #2 with another, both investments are held in a single RRSP account with the nominee, a chartered bank. The main benefit of a nominee account is the ability to keep track of all RRSP investments within a single account. The main detriment is that nominee accounts often incur annual fees. A “self-directed” RRSP (SDRSP) is a special kind of nominee account. It is essentially a trading account at a brokerage that has tax-sheltered status. The holder of a self-directed RRSP instructs the brokerage to buy and sell securities on their behalf as with any brokerage account. The reason that it is described as “self-directed” is that the holder of this kind of RRSP directs all the investment decisions themselves, and does not normally have the service of an investment advisor.

Intermediary accounts: Intermediary accounts are essentially identical in function to nominee accounts. The reason investors would have an intermediary account instead of a nominee account has to do with the investment advisor they deal with, as advisors not aligned with a major bank or investment dealer may not have the logistical ability to offer nominee accounts to their clients. As a result, the advisor will approach an intermediary company which is able to offer the investor identical benefits as those offered by a nominee account. The two main Canadian financial institutions that offer intermediary services are B2B Bank and Canadian Western Trust. The main benefits and detriments of intermediary accounts are identical as those offered by nominee accounts.

Receiving income from an RRSP

If you are near retirement, you may be thinking about getting regular income from your RRSP. You generally have a certain amount of flexibility on the types of income you can receive. Contact your RRSP issuer to find out what your options are. At any age up to the end of the year you turn 71, you can choose one of the following options for your RRSPs.

You can transfer your RRSP funds to a registered retirement income fund (RRIF). Starting in the year after you establish a RRIF, you receive a minimum amount each year using a predetermined formula based on the value of the RRIF and your age. Your RRSP issuer will not withhold tax on amounts that are transferred directly to a RRIF. You may have to pay tax on the income when you start receiving payments from the RRIF. Enter these payments as income on your return for the year you receive them.

You can use your RRSP funds to purchase an annuity. Annuities offer a guaranteed income for life or for a specified period. Your RRSP issuer will not withhold tax on amounts that are used to purchase an annuity. You may have to pay tax on the income when you start receiving payments. Enter these payments as income on your return for the year you receive them. You can claim the pension income amount when you receive annuity income if you were 65 or older on December 31 of the year. You receive the annuity income due to the death of a spouse or common-law partner. (Annuity payments are shown in box 16 of a T4RSP slip, Statement of RRSP Income. Report the income on line 129 of your tax return. Claim any tax deducted from box 30 of your T4RSP slip on line 437 of your tax return.)

You may have received commutation payments from an RRSP. A commutation payment is a fixed or single lump-sum payment from your RRSP annuity that is equal to the current value of all or part of your future annuity payments from the plan.

Your RRSP may now be an amended plan. If, in 2012, your RRSP was changed and it longer satisfies the rules under which it was registered, it is no longer an RRSP. It is now an amended plan or fund. In such a case, we consider you to have received in 2012 an amount that equals the fair market value of all the property the plan held at the time it ceased being an RRSP.

You may have other income and deductions from an RRSP. You may have to include other RRSP amounts in your income, or you may be able to deduct other amounts for 2012. This applies if, in 2012, your RRSP trust holds at any time a non-qualified investment or disposed of a non-qualified investment. It also applies if trust property was used as security for a loan, sold for an amount less than its fair market value, or the trust acquired property for an amount more than its fair market value.

RRSP Rollover

It is possible to have an RRSP roll over to an adult dependent survivor, child or grandchild, as it would to a spouse. This was made possible in 2003 and there are various Income Tax Act (ITA) requirements to allow this to take place. The new registered asset could result in provincial benefits being cut off. In many cases a court application to have someone appointed guardian of the child’s property and person would be necessary to provide a legally authorized party to manage the asset if the child is deemed incompetent to do so. This possibility has an impact on the overall estate plan and often the distribution of the estate.
Acquiring this asset may also impact the adult dependent child’s eligibility for provincial assistance programs. A Henson trust may be useful for enabling the adult dependent child to receive RRSP rollovers and still be eligible for provincial social assistance programs such as Ontario Disability Support Program (ODSP). A Lifetime Benefit Trust (LBT) is a new option that may be valuable for leaving a personal trust in a will for a special needs, financially dependent child, grandchild or spouse. It has the added benefit that RRSP assets dedicated to the LBT could be protected from creditors.

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